The Blessing and Curse of Global Sourcing and Supplier Management

As discussed in The Gain and Pain of Global Retail Sourcing, for anyone who has not spent the last several years in hibernation or stranded on a remote island, it has become apparent that several market-driving forces have come together to create a perfect storm, one that makes control of the supply side more important to overall business success than ever before. Some of these driving forces include globalization (the prospect of new potential markets, but at the price of growing competition), sourcing in low-price and low-wage countries (and even outsourcing of some, if not most, manufacturing or service operations), and continuous cost pressures (that is, ever shrinking margins).

Although global strategic sourcing might be as old as sailing ships and riding on camels, there has been much talk these days about globalization and its effects on business, and there is no doubt that competing corporations are increasingly butting heads in the global playing field. But the same globalization of sourcing, manufacturing, and delivery processes is also making supply chains far longer and more complex than ever before; they require more coordination and collaboration amid trading partners. Indeed, many manufacturers and retail chains have expanded both nationally and globally, creating the need for more formal and structured mechanisms to coordinate supply chain activities.

What's more, market demands are becoming more volatile and harder to predict due to the increasing power and speed of information available to both comparison-shopping consumers and competitors. Global sourcing can be defined as the process of identifying appropriate domestic and far- or near-shore suppliers of goods and services (preferably from countries with significantly lower cost bases), ordering the goods, and arranging for their payment and delivery. Global sourcing has become a standard practice for many businesses. In fact, global sourcing has become increasingly important as a corporate strategy, and is rapidly developing into a survival strategy tooa sharp contrast to its stepchild and ugly duckling treatment of previous decades in procurement departments.

Contrary to yesteryears, today there is a growing imperative within organizations to source directly from an ever-expanding global universe of prospective vendors. According to the World Trade Organization (WTO), about 55 percent of all raw materials for American manufacturing are now sourced outside the United States (US) compared to the approximate 12 percent in the 1980s. As another example, not that long ago, the Wall Street Journal reported huge increases in the volume of Far East imports through the port of Savannah, Georgia (US), where the cargo container volume of 1.7 million shipment units per year of a decade ago has tripled.

The Global Sourcing Allure

In a nutshell, companies source globally for three main reasons: to differentiate their products (in terms of affordability, quality, availability, etc.), to gain competitive advantages through reduced price points, and to realize margin improvements. Many recent studies, surveys, and benchmarking reports have concluded that a well-devised and well-executed sourcing strategy can produce up to a 2 percent improvement in margin (through more efficient trading partner collaboration), reduce cycle times by up to 30 percent, reduce cost of goods sold (COGS) by up to 5 percent, and increase gross margins by up to 15 percent.

The above percentages are achieved through increased international sourcing of low-cost labor and supplies from East and Southeast Asia, Eastern Europe, and South America, with Africa slowly showing signs of becoming the next potential frontier. Sure, expectations are usually much higher than the above figures, since initial savings might provide false gains, but with many costs and risks being hidden (such as logistics complexity and increased lead time ramifications), businesses should always take a long-term view and make the appropriate analysis (but more about the impediments later on).

What's more, trading quotas and other barriers have been disappearing (or are being significantly reduced) globally, while the expansion of the European Union (EU) eastward opens up new potential countries to source from as well new potential markets in which to sell. With the end of apparel import quotas, this sector is growing rapidly in India and the Far East, while the passage of the Central America Free Trade Agreement (CAFTA) promises to bring additional activity into Central America as well. Today, consequently, retailers are, on average, following the top executive mandates to increase imports of both raw materials and finished goods to up to a quarter of total purchases (a substantial increase from the current level of 5 to 12 percent).

Additionally, there has been an increasing awareness of suppliers having more strategic importance; retailers and manufacturers are trying to nurture long-term collaborative partnerships with their trading partners and to leverage the suppliers' strengths and savvy, all with the idea of forging win-win relationships (as opposed to the traditional price- and transaction-based, buy on the market encounters that only benefit one sideusually a large channel master). For instance, many organizations have realized significant benefits when they involve suppliers in the early stages of product life cycles. Taking the conceptual design process (new product idea or old product enhancement) as an example, such benefits can include lower costs for development, purchased material, and manufacturing; shorter development times; and better quality of purchased material and in final product feature levels.

Similarly, a strategy for mass customization (also known as postponement or delayed differentiation) should give organizations a competitive advantage, but this requires the quick and efficient delivery of a wide variety of customized goods or services at a low cost. Again, early supplier involvement (as opposed to after the product has already been designed and thrown over the wall) is critical to maximizing the potential of the postponement strategy. In this respect, a supplier's involvement typically adds value and improves time to market (that is, getting products into the hands of customers more quickly) while helping to ensure quality, and ultimately increases customer satisfaction and loyalty.

Furthermore, in some industries and markets (pharmaceuticals, for example), strategic alliances, joint ventures, or ongoing partnerships may enable organizations to combine resources and share the burden as a way of overcoming barriers to entry into the market, as well as in searching for and developing new opportunities. In other industries, such as home improvement and appliance design and manufacturing, partnerships between retailers and manufacturers that lead to better advertising or increased access to new market channels are certainly mutually beneficial.

According to the 2004 report from sourcing consultants A.T. Kearney titled Making Procurement a Priority, true market leaders are collaborating more than ever with suppliersand in a true win-win manner. This collaboration is occurring mostly in the areas of product design (development), supply chain (logistics), merchandising strategy, and strategic and tactical buying. The rapidly changing face of global supply emphasizes the importance of strategic partner collaboration (that is, strategic relationships, differentiated primarily by deeper levels of planning and workflow integration, and sharing of information) and supplier performance measurement in enabling top-notch sourcing operations.

Backed by more recent data from analysts Aberdeen Group and strategic consultants McKinsey & Company, there are many indications that leading retailers gain from working collaboratively with their suppliers to facilitate visibility across the entire supply chain, starting from product concept stage to product deliveryeven to the supplier's shop floor. Also, today's leading retailers increasingly try to ensure that their corporate social responsibility (CSR) policies and practices are integral parts of their supply chains, and they are therefore adhering to ever more responsible sourcing practices by harnessing conscientious trading partners' expertise (for example, those that abide by the US Fair Labor Standards Act [FLSA]). For more information, see Global Trade and the Role of Governance, Risk Management, and Compliance Software.

Nurture Thy (Strategic) Suppliers

Because of the rise in global competition, mass customization, customer expectations, and price and margin pressures, enterprises are relying more heavily on external suppliers to contribute ever larger portions of parts and components, materials, ingredients, and (sub)assemblies to finished products. Businesses also need reliable suppliers to manage a growing number of processes and functions that were once controlled internally (albeit this change has the potential to create many risks, which will be addressed later on).

While market consolidation has greatly affected both sides of the supply chain, its effects can especially be seen on the supply side (upstream). Namely, producers of raw materials and manufacturers of parts or materials may now have much larger, yet fewer, customers that control a greater portion of the market and that may be better able to mandate terms that will lower their own costs. However, at the same time, these high-and-mighty retailer-customers may have fewer suppliers to choose from and less flexibility in the terms they are able to negotiate. Sure, the expansion of global markets may mitigate some of this pressure, but those benefits must always be weighed against increased transportation costs and the risks stemming from the morass of political instability, currency fluctuations, language barriers, trading quotas, labor laws, regulations, time zones, intermediaries, etc.

In addition to a greater focus on the customer and the downstream side of the supply chain, another major shift in today's business culture is the pervading integration that occurs both internally and externally. To be clear, focusing on the customer includes both internal customers (the recipients of another person's or department's output within the enterprise) and external customers (recipients of goods, services, or information who are not part of the company supplying it), and helps to reach the ultimate goal of creating so-called customers for life. Internal integration occurs within an enterprise, and is aimed at increasing communication and collaboration among all departments or areas involved in producing what is sold. External integration involves greater sharing of information and processes between parallel departments of supply chain partners.

Pressure on price and profit margins is also conducive to greater integration of manufacturers with suppliers, since one way to respond to a trend toward commodity pricing is to distinguish one's product by adding value to it, and this can be done at many points in the supply chain. Conversely, in the case of commodity products (where hardly any value can be added within the supply chain), the company must compete on price and availability, where cost-effective performance becomes critical. Achieving and maintaining that performance nonetheless requires close integration among the supply chain partners, from planning and goal setting through to order tracking and inventory replenishment.

As partnerships tend to use long-term contracts, the length of the relationship creates opportunity for increased understanding of each other's organizations and increased efficiencies through greater communication. Given that demand increase can be achieved by satisfying unmet customer needs or by allowing changing price premiums for the higher value products delivered to the marketplace, all trading partners sharing their knowledge about the market and consumers is necessary for a successful demand enhancement strategy. For example, retailers are often better able to gauge the preferences of consumers because of their close contact with them, whereas manufacturers and suppliers might have a broader perspective thanks to the multiple markets they serve. When manufacturers and retailers collaborate and share information, they can develop products that are better able to meet the needs of the end customer, and they are also better able to communicate the benefits to those customers.

Supplier relationship management (SRM), which is a methodology (and an enterprise software category per se) to structure and support relationships with suppliers, comes into play when a supply chain recognizes the benefits of strategic sourcing. The APICS Dictionary (11th edition) defines strategic sourcing as the development and management of supplier relationships to acquire goods and services in a way that aids in achieving the immediate needs of a business. Yet, although collaboration has become a popular buzzword in today's supply chains, it has proven to be much easier said than done, since the relationship between retailers (customers) and manufacturers (suppliers) remains largely transactional and at an arm's length (distant) at bestand adversarial at worst. Indeed, in many cases, customers will still place orders in a one-way form of communication (with little or no feedback), whereas two-way communication typically only kicks in when something goes wrong (and is possibly beyond repair).

This is part one of the series The Blessing and Curse of Global Sourcing and Supplier Management. In part two, strategic sourcing and its benefits for enterprises are discussed in greater depth.